Part 530 And IRS Employment Tax Audits: Employee Classification And Aid – Tax Authorities

Worker Classification and Section 530 Relief

Employers are required to pay employment taxes to the IRS.

Generally, these payments consist of two portions: the

employee’s portion of FICA and income taxes and the

employer’s portion of FICA and unemployment (FUTA) taxes.

Employers who fail to timely remit employment taxes to the IRS run

the risk of being held liable for not only the employment taxes,

but also penalties and interest for late payment.

But independent contractors are treated

differently than employees. Specifically, if a worker is properly

characterized as an independent contractor (as opposed to an

employee), the taxpayer making payment to the independent

contractor is not required to remit payment to the IRS. Rather, the

independent contractor-particularly in the case of an individual

sole proprietorship-pays self-employment taxes on the

business’s net income.

Because of the distinction, taxpayers generally prefer to treat

their workers as independent contractors. Conversely, the workers

prefer employee treatment. In most instances, the tie will go the

taxpayer-payor, though, because the payor has more leverage over

the characterization of the worker as an independent contractor or

employee. That is, at least via contract.

Of course, the IRS is well aware of taxpayers’ general

inclinations to treat their workers as independent contractors.

Congress is too. Accordingly, under federal tax law, the IRS has

the authority to recharacterize workers as employees, even if the

two agree that they should be treated as independent


Taxpayers in these situations are not without defenses. Although

there are many, a common defense that may be raised is Section 530

relief. To the extent a taxpayer can convince the IRS Section 530

relief applies, the taxpayer can avoid costly employment taxes.

Moreover, the taxpayer can continue to treat their workers as

independent contractors. A brief summary of Section 530 relief is

discussed below.

Common Law Factors (Employee v. Independent Contractor

Prior to getting into Section 530 relief, it is important to

understand the difference between an employee and an independent

contractor. Under federal tax law, the term “employee” is

defined to include “any individual who, under the usual common

law rules applicable in determining the employer-employee

relationship, has the status as an employee.”1 The

common law test looks at a multitude of factors-none necessarily

determinative-as a means to analyze the relationship between the

taxpayer and the worker.

The governing regulations provide additional color on the

characterization of a worker as an employee or independent

contractor. Under those regulations, the primary factor in

determining whether a worker is an employee or an independent

contractor is the extent of control the payor has over the work

performed.2 However, federal tax law also look at other

factors, such as: (1) which party invests in the facilities used in

the work; (2) the opportunity of the worker to make a profit or

loss; (3) whether or not the principal has the right to discharge

the individual; (4) whether the work is part of the principal’s

regular business; (5) the permanency of the relationship; and (6)

the relationship the parties believe they are


Section 530 Relief.

Since 1978, Congress has provided so-called Section 530 relief

to taxpayers who meet all of its requirements.4 These

requirements include: (1) the consistency requirement; (2) the

historic treatment requirement; and (3) the reasonable basis

requirement. Each of these requirements is discussed in turn


Reporting Consistency Requirement.

The reporting consistency requirement looks at whether the

taxpayer has consistently reported the worker as an independent

contractor. Accordingly, the IRS looks at whether the taxpayer has

issued Forms 1099 each year to the worker or group of

workers.5 Although some courts have disagreed, the IRS

also contends that the Forms 1099 must have been filed timely to

satisfy this requirement.

Historic Treatment Requirement

Under the historic treatment requirement, the taxpayer must not

have treated an individual (or individuals in substantially similar

roles) as an employee for any period beginning after December 31,

1977. To the extent the taxpayer has treated certain workers as

employees, Section 530 relief does not apply.

Reasonable Basis Requirement.

In many cases, taxpayers can sufficiently show compliance with

the reporting consistency and historic treatment requirements.

However, the third requirement-the catch-all reasonable basis

requirement-tends to be a more difficult sell for taxpayers to make

to the IRS. The safe harbors and the catch-all reasonable basis

standard are discussed below.

Safe Harbors and Other Reasonable Basis Standard.

The legislative history of Section 530 provides taxpayers with

some help in satisfying their burden of proof in showing reasonable

basis. Specifically, that legislative history indicates that the

reasonable basis requirement should be construed

“liberally” in favor of taxpayers.6 Although

the standard is a helpful one, the taxpayer still has the initial

burden to show relief. Moreover, taxpayers should be cautious that

under many of the reasonable basis standards, the IRS and federal

courts will not permit taxpayers to use “after-the-fact”

reliance arguments.7 That is, in some instances, the

taxpayer must show that they were aware of and relied upon the

factors prior to making a determination to treat the

workers at issue as independent contractors.

Judicial Precedent, Published Rulings, Technical Advice, or a

Letter Ruling.

The first safe harbor is reliance on certain federal tax

authority. A taxpayer meets this requirement if the taxpayer can

show reliance on judicial decisions and/or IRS published rulings,

provided the facts in those tax authorities are substantially the

same as the facts under audit.8 A taxpayer also meets

this safe harbor requirement if the taxpayer received technical

advice or a letter ruling from the IRS regarding the worker


Prior IRS Audit.

The second safe harbor applies if the taxpayer can show: (1) the

IRS previously audited the taxpayer; (2) the IRS determined in that

prior audit that the taxpayer’s workers were independent

contractors; (3) the workers subject to the prior audit were

substantially similar to the workers at issue; and (4) the taxpayer

treated the two groups of workers in a substantially similar

fashion.10 Generally, an audit occurs when the IRS, at a

minimum, looks at the taxpayer’s books and


Long-Standing Industry Practice

The third safe harbor applies if the taxpayer can show a

long-standing industry practice. More specifically, the taxpayer

must show that: (1) a long-standing recognized industry practice

exists in a significant segment of the industry; and (2) the

taxpayer reasonably relied on this practice in the tax treatment of

its workers.12 For these purposes, a significant segment

does not mean a majority-rather, “one or two businesses may

constitute a significant segment of an industry.”13

A number of taxpayer-friendly rules apply under this safe harbor,

particularly because the evidentiary burden on the taxpayer is

perhaps the greatest under this safe harbor.

“Catch-All” Reasonable Basis.

In many instances, a taxpayer will not fall under any of the

safe harbors. If this occurs, the taxpayer will need to persuade

the IRS that the catch-all reasonable basis standard applies.

Although this standard considers almost any relevant factor, it is

often the most difficult of the standards to have the IRS agree

upon.14 Accordingly, taxpayers who intend to rely on

this factor should ensure that they properly set forth their

arguments and supporting facts to the IRS.

Relief from Improperly Classifying Workers

Used appropriately, Section 530 relief is a powerful

taxpayer-friendly rule in disputed worker classification issues

with the IRS. However, Section 530 is not an easy statute to

understand. Aside from the above matters, which have only been

discussed briefly, Section 530 contains a litany of other complex

procedural matters, including proper timing to raise the defense,

proper presentment of evidence, and certain burden-shifting

mechanisms. To the extent the taxpayer properly utilizes Section

530, though, the taxpayer can substantially reduce its exposure to

several years of employment taxes and subsequent treatment of

workers as employees.


1 26 U.S.C. § 3121(d)(2).

2 See Treas. Reg. §§ 31.3121(d)(1) (FICA);

31.3306(i)-1 (FUTA); see also Peno Trucking, Inc. v.

Comm’r, 296 Fed. Appx. 449 (6th Cir. 2008).

3 Peno Trucking, Inc., 296 Fed. Appx. At 456, and cases

cited therein.

4 Revenue Act of 1978, Pub. L. No. 95-600.

5 See, e.g., CCA 200948043 (noting that issuing a Form

W-2 to a worker would be inconsistent with claiming the worker as

an independent contractor).

6 See H.R. Rep. No. 1748, 95th Cong., 2d Sess. 5,

1978-3 C.B. (Vol. 1) 629, 633.

7 See, e.g., 303 West 42nd St. Enters. v. IRS, 181 F.3d

272, 277 (2d Cir. 1999 (focusing analysis on whether the taxpayer

“in fact relied on” the grounds alleged); Nu-Look

Design Inc. v. Comm’r, 85 T.C.M. (CCH) 927 (2003)

(“The statute does not countenance ex post facto

justification.”); Veterinary Surgical Consultants, P.C. v.

Comm’r, 85 T.C.M. (CCH) 901 (2003) (courts must apply

Section 530 relief when “the taxpayer . . . relied on the

alleged authority . . . at the time the employment decisions were

being made.”).

8 See CCA 200948043 (“As to judicial precedent or

published rulings, the Service will look to whether the facts of

the judicial precedent or published rulings are sufficiently

similar to the taxpayer’s facts.”).

9 See CCA 200948043 (noting that PLR and TAM do not

provide a safe harbor to the taxpayer in question because those

were issued to other taxpayers).

10 See Smokey Mountain Secrets, Inc. v. U.S., 910 F.

Supp. 1316, 1325 (E.D. Tenn. 1995) (citing Lambert’s

Nursery and Landscaping, Inc. v. U.S., 894 F.2d 154, 156 (5th

Cir. 1990).

11 Conference Report, H.R. Rep. No. 104-737, 104th Cong., 2d

Sess., at 200 (1996).

12 Texture Source, Inc. v. U.S., 851 F. Supp. 2d 1260,

1265 (D. Nev. 2012).

13 Hospital Resource Personnel, Inc. v. U.S., 68 F.3d

421, 427 (11th Cir. 1995).

14 See, e.g., Nelly Home Care, Inc. v. United States Nelly,

LLC, 185 F. Supp.3d 653 (E.D. Penn. 2016); see also

H. Rep. No. 1748, 95th Cong., 2d Sess. 5, reprinted in

1978-3 C.B. 629, 632-33 (noting that Section 530 was intended to

“grant( ) relief if a taxpayer had any reasonable basis for

treating workers as other than employees.”); CCA 200948043

(“A taxpayer who fails to meet any of the three safe harbors

may nevertheless be entitled to relief if the taxpayer can

demonstrate, in some manner, a reasonable basis for not treating

the individual as an employee.”).

The content of this article is intended to provide a general

guide to the subject matter. Specialist advice should be sought

about your specific circumstances.

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